Rewarding Business

Performance
Chapter 25

McGraw-Hill/Irwin Copyright © 2010 by The McGraw-Hill Companies, Inc. All

Motivation and Aligning
Goals and Objectives

Goal Congruence
Alignment of employee goals
and objectives with
organizational goals and
objectives.

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Motivation and Aligning
Goals and Objectives

Feedback
 Steer employees
Measure
toward goals
performance
 Measure progress
in achieving goals

Improve Reward
performance performance.
performance

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Return on Investment (ROI)
Return
Return on
on investment
investment isis the
the ratio
ratio of
of
operating
operating income
income to
to the
the average
average
investment
investment used
used to
to generate
generate the
the income.
income.

Operating Income
ROI = Average Total Assets

Using ROI to evaluate business

performance
is often referred to as the DuPont system.
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Return on Investment (ROI)

Operating Income
ROI = Average Total Assets

Operating Income Sales

ROI = Sales × Average Total Assets

Return Capital
on Sales Turnover
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Improving ROI
 Decrease
Expenses
 Increase  Lower
Sales Invested
Prices Capital

Three ways to improve ROI

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Criticisms of ROI
 Asdivision manager at Winston, Inc., your
compensation package includes a salary
plus bonus based on your division’s ROI --
the higher your ROI, the bigger your bonus.
 Thecompany requires an ROI of 15% on all
new investments -- your division has been
producing an ROI of 30%.
 Youhave an opportunity to invest in a new
project that will produce an ROI of 25%.

As division manager would you

invest in this project?
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Failure to Undertake
Profitable Investments
Gee . . .
I thought we were As division manager,
I wouldn’t invest in
supposed to do what
that project because
was best for the
it would lower my pay!
company!

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Residual Income and
Economic Value Added
Operating Earnings
– Investment charge
= Residual income

Investment capital
× Minimum return
= Investment charge

Investment center’s
minimum acceptable
return
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Residual Income
Residual income encourages managers to
make profitable investments that would
be rejected by managers using ROI.

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Economic Value Added
Economic value added is the annual after-
tax operating profit minus the total annual
cost of capital.

Cost of capital is weighted-average after-tax

cost of long-term borrowing and the cost
of equity.

Equity Debt

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 Economic Value Added
After-tax Operating Income
– Investment charge
= Economic value added

(Total assets – current liabilities)

× Weighted-average cost of capital
= Investment charge

After-tax cost of
long-term borrowing
and the cost of equity
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Economic Value Added
Economic
Economic value
value added
added can
can be be
improved
improved in
in three
three ways
ways .. .. ..
Increase
 Increase profit
profit without
without using
using more
more
capital.
capital.
Use
 Use less
less capital
capital to
to earn
earn the
the same
same amount
amount
of
of profit.
profit.
Invest
 Invest capital
capital in
in high-return
high-return projects.
projects.

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 Balanced Scorecard
Financial Perspective
How do we look
to the firm’s owners?

Learning and Growth Vision

Business Process
Perspective Perspective
and
How can we continually In which activities
improve and create value? Strategy must we excel?

Customer Perspective
How do our
customers see us?
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Difficulties with the
Balanced Scorecard
Some of the difficulties noted by companies using
the balance scorecard include:
1.Organizations have difficulty assessing the
importance or weights attached to the various
perspectives that are part of the scorecard.
2.Measuring, quantifying, and evaluating some of
the qualitative components that are part of the
balanced scorecard present significant technical
hurdles.
3.Difficulty arises from a lack of clarity and sense of
direction because of the large number of
performance measures.
4.The time and expense required to maintain and
operate a fully designed system can be significant.
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End of Chapter 25

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